Why is it so hard to see that debt to private and public entities is available at very different interest rates that reflect higher risk premia assessed to the former? No financial intermediary will lend anything
to a household or a corporation at an interest rate arbitrarily close to zero but they will to the government… Insane.

As for wasted resources, if the projected doubling of the unemployment rate doesn’t signal their inefficient use, it’s hard to see what might.

Is a simple way of looking at this as follows – the preferred vehicle for savings these days seems to be Treasuries, so the only way for savings to invigorate the economy is for the government to borrow and
spend?

Actually, proposition two is perfectly correct: The money must come from somewhere. The issue really is whether proposition 3 is true. You think stimulus effects are in fact going to do something more positive than
what would have been done with the money if it weren’t borrowed. And that is a reasonable claim. If people were just going to hoard the money anyways, it couldn’t possibly add ANY value to the
economy (at least in the short-term). So, having government spend it — even if imperfectly — will add more value. Another way to say this is to say that the macroeconomic impact of government spending
MAKES it worth borrowing.

Of course, there are other issues — maybe the borrowing by government somehow makes people more likely to spend themselves (i.e. hoard less even out of the funds that are left AFTER lending to government)
— just because they believe that the government spending will work. So, then borrowing is an action that actually affects the dynamics of behavior itself. Or maybe people will think government will overwhelm
itself in debt. This view could then cause a withdrawal of money from the US economy. Or maybe the borrowing will come from foreigners?

But the point is that these are ALL empirical questions. Economists (including you) are getting hung up on language and semantic discussions.

Sure, under certain conditions (which I don’t think are true, but also aren’t too far-fetched), deficit spending can fund itself through increasing incomes and therefore savings, IF we assume simultaneity.

But simultaneity is a poor assumption. Government must borrow the money first (from somewhere), and then spend it, increasing incomes, which in turn creates some savings and some consumption… the consumption,
in turn, creates additional income, and so on.

Sadly, the story we generally tell (higher incomes increase consumption, which in turn increases incomes more) to explain the multiplier is far more true than the calculation we do to find it. The story acknowledges
the passages of time. The calculations do not.

Once we eliminate the assumption of simultaneity, Fama is basically right. At a given point in time, the quantity of savings available to fund projects is basically fixed, and one organization using it will mean
that another cannot.

And statement 1 is also false when the government can issue a fiat currency.

Statement 2 is also confusing real flows and financial stocks (as has been widely discussed in the blogosphere). It requires a flow of money and a flow of resources for government spending. But the money comes back
(the money the government spends goes in somebodies pocket, who puts in in a bank account). The stock of money may not have changed, but the velocity has changed.

I’m afraid that both fresh-water and salt-water economists have been losing their rigor in the midst of this crisis. Even you: In a previous post, you describe the new Keynesian models as follows.

“And by the way: these are extremely buttoned-down models, with lots of intertemporal maximization, careful attention to budget constraints, and at most some assumption of temporary price rigidity. ”

The truth, unfortunately, is that these models are not extremely buttoned-down at all. For example, your own “ultra-wonkish” paper posted here on December 29th not only assumed temporary price rigidity,
but also assumed that people get utility from money. Putting money in the utility function might be a reasonable short-cut in some circumstances, but definitely not in this case. If people hold money because
they fear deflation, you’d better allow that deflation to happen in equilibrium rather than forbidding it through sticky prices. I’d prefer to see strong policy statements being buttressed by better
models than this.

Is it just me or do notice that people with master’s degrees and PhD’s in Finance automatically assume that they are economics experts, or at least, experts on the economy?

Financial markets are only a part of the overall economy and finance types seem to only look at it from a perspective of corporations and shareholders. Maybe this is why they give so little thought to the rationale
and decision-making of individuals and non-corporate groups. They seem to end up totally discounting things like greed and moral hazard (thank you, Mr. Greenspan) and only view the world through a corporate
lens (thank you, Republican Party).

These financial experts may be correct in interpreting the impact of the economy on financial markets, but the impact of financial markets on the economy is not the same thing, nor is it the only aspect of the economy.
A financial education does not yield and economist.

Fama says: “3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.”

Moving resources that (due to lost confidence) consumer hold under the matress and banks at central bank accounts to infrastructure projects seems to me a more productive use. Thus, this stimulus plan will enhance
incomes.

I’m tire of people operating as though the gov’t takes their money (or borrows it from someone) and then buries it in the back yard.

My argument goes like this: whether you pay welfare, unemployment or your local bureaucrat, the money doesn’t go offshore, it doesn’t get levered so it can short RBS, or play the bond market, it doesn’t
get flushed down some $3,000 gold plated pentagon toilet, it gets spent, locally, in your grocery store, at your local Walmart, at your local Chevy dealer, your local restaurants, your organic co-op (democrat),
your local gun store (republican), IN YOUR TOWN.

I think that meme is simple and resonant enough for most Americans to understand and get behind. I wish someone in authority would start using it.

Fama’s 3rd statement: “stimulus plans only enhance incomes when they move resources from less productive to more productive uses”.

is the crux of the matter. Economies grow when good investments are made, they falter when bad investments are made. Policy can only effect the economy when it shifts the flow of capital toward the people with better
information.

The fundamental assumption of the Chicago school is that individuals have better information than the government. Given that this is true, reducing taxes, government spending, and regulation is good. And as Von
Hayek describes in his papers, there are lots of reasons to think this is generally so.

But it is not always so. Individual decision-makers are subject to their own constraints. When relevant information is distant, they rely on communication from others. Individual judgments can be come highly correlated
and lose their independence. From this we get bubbles and depressions. I buy dot.coms because you buy dot.coms, I put my money under the mattress because you put your money under the matters, etc. At these times,
the “public good” of independent judgment has been lost, and the aggregate of individual decisions are worse, not better, than the decision of an entity with a more heterogeneous (perhaps bordering
on arbitrary) set of goals — the government.

Right now, the government has the least incentive to hoard money and so, flawed though it is, it has the best chance of picking investments that will pay off. Once the government does this, there are new events
to judge, increasing the possibility that individuals will begin making independent judgments again. This is when capital markets will work properly and we can return to our normal model.

Naive view, I imagine, but isn’t there a big difference between savings $$ that are:

(a) in a mattress or bank that refuses to lend for fear of its own survival

(b) deployed to pay salaries or buy goods.

So even if total savings is fixed, it matters a lot whether they are in (a) or (b). The idea of a fiscal stimulus is to move $$ from (a) to (b) where they can be redeployed for even more good effect. Conversely,
a tax cut could not only be less effective, it might actually move $$ backwards, from (b) to (a), which spending, perforce, cannot do.

The other idea of a fiscal stimulus is psychological, that is, to convince the folks in (a) to get their money moving, because things are about to improve.

In that regard, the Republican intransigence and pessimism — it won’t work; I hope he fails; etc — can make things worse, that is, if anybody listens to them.

To those who claim private savers will hoard their current holdings as evidence the government will use their savings more efficiently – you are missing two important points.

1) The reduction in savings will not be via the tax mechanism. The government will fund the stimulus by reducing FUTURE savings in one of two ways: increasing the debt via borrowing or devalue future savings via
expanding the money supply. What this means is that we are comparing the longterm productivity of the US Government’s application of these future savings to the longterm productivity that would result
if the future debt/inflation burden were not to be increased via present action.

2) While hoarding money will reduce productivity in the short run – it will also allow for deflation which will lead to more buying power; an increase in savings over time. The current stimulus package will
serve to sustain inflation as it will 1) grow the money supply and 2) create almost a trillion dollars of artificial demand which will keep prices rising.

Eventually the government will not be able to continue providing artificial demand for it’s new and/or improved industries. If a the bureaucracy manages to allocate funds in such away that these new industries
remain profitable without the subsidization of future tax payers then this plan may work.

Fama’s point appears to be that the government functions in such a way (inefficiently) that the likelihood of a bureaucratically designed dream industry is close to nil.

Lucas you are right except that one party (private investment) is not willing to spend. You give them more and they’ll hoard it. That’s what Fama is ignoring. Problem is banks are not willing to lend.
Companies are not willing to invest. Spending is necessary if we want to stop this crisis from deteriorating. Government is the only one who can spend at this time.

“Fama says: “3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.”

This indicates that he is implicitly working from a market-clearing model in which all resources are always fully employed and, if resources are to be moved to one particular use, they have to be moved out of another
use.

Keynesian models, being non-market-clearing models, recognize that in a recession there are resources that are UNEMPLOYED, like, for example, involuntarily unemployed workers. What increased government expenditures
do is that they move economic resources from being unemployed to being employed. The resulting increase in output and income increases the amount of saving and therefore provides the additional loanable funds
to finance the borrowing needed to pay for the government expenditures. Therefore the government borrowing does not take any loanable funds away from private uses.

I can’t help but feel amazed that there are people who believe deflation is a desirable condition because it encourages savings.

Yes, it encourages savings, but it also discourages any economic activity, leading to a death spiral in the economy. Companies won’t be able to sell products as customers know that the price will be lower
in the future. Interest rate will fall to 0 as nobody needs any incentive to save (price reduction alone does), and nobody wants to borrow to invest as it’s impossible to make money to pay back the loans
given that future product prices will continue to fall.

It benefits no one except those who has enough savings right now that they don’t need to earn income from employment (because unemployment will be high, wages will be low and declining.)

Marry Ricardian equivalence theory and equilibriu m business cycle theory and what have you got? True neutrality. Why don’t we all just go off to another profession since we have nothing to say, apparently.
Thank the Lord Paul Krugman and Larry Summers are renegades and are speaking out.

Can anyone tell me the source of the House Republic (I’ve dropped the “an”) members are getting their analysis: half the stimulus package ($400b) creates twice the jobs (6m jobs). I want some
of that medicine. They attribute it to C. Romer, but what is the specific source?

Admittedly, I am moving away from the Fama-Krugman debate, but I cannot help but wonder if a more efficacious policy than subsidizing consumption might be subsidizing savings via a grant of savings from government
to households. Stimulating consumption through tax cuts or other transfers seems self-defeating in a time when households are compelled to restore their balance sheets (akin to banks restoring their balance
sheets by cutting back on lending). They save what you give them through tax cuts until some future time period when they are feeling secure enough to resume spending. Either that, or they are so broke that
they spend every centime on food along the way.

With savings in the bank, households might be more willing to spend from income. Certainly, the savings grants would have to vest. Indeed, perhaps the vesting could be back-loaded such that the longer a household
waits to draw on them, the higher the return, calculated retrospectively.

And, because wealth in effect de-cumulates in a deflationary environment, perhaps the savings grants would have to come with returns guaranteed by government in amounts at least sufficient to offset the decrement
to wealth attributable to deflation.

The obvious question is whether promulgation of savings be a cheaper route for government at the end of the day than the fiscal stimuli aimed at increasing consumption. You are the expert, and I defer to you. I
certainly acknowledge your position regarding one form of debt replacing another… Is it not the same position held by Martin Wolf at the Financial Times?

I am reminded of Chancellor Brown’s speech which the Queen read at the opening of Parliament and which contained explicit citations for increasing savings. As a “savings advocate,” I enjoy the
different European perspective on how to dig our way out of this mess.

Beyond all the above, it seems we are in danger of becoming a nation of cash hoarders and day traders… to offset the loss in the value of our accumulated wealth.

On the face of it, it seems too facile to say that savings “is” an endogenous variable. Wouldn’t that depend on what model you’re using? Someone could write down a static model in which
savings are predetermined and the only equilibrium is one where investment equals that predetermined savings.

The problem is that the dynamics don’t work. Any sensible dynamic assumptions will make the equilibrium unstable.

The sensible dynamics go something like this. What happens when there is an incipient increase in income and people try to save the same amount? Their consumption goes up, so there’s another incipient increase
in income. And then they still try to save the same amount, so their consumption goes up again, and there’s another incipient increase in income, and so on. Income keeps rising, and consumption keeps
rising, and there is no way to get back to the equilibrium.

The only way to make the dynamics stable is to have some mechanism that will either increase savings or reduce investment under these circumstances. If there’s a binding resource constraint, some combination
of price and interest rate changes can force investment back down, but again, Professor Fama insists that the resource constraint is irrelevant. And if savings are exogenous, then by definition, there can’t
be a mechanism within the model that increases them.

It’s only sensible to assume that there is at least a non-binding resource constraint. In that case, in this model where savings are exogenous, the result of an upward disturbance in equilibrium (if I’m
not mistaken) will be an increase in consumption to the point where total income reaches the resource constraint. Then the resource constraint will force investment back down to equal savings. But in the mean
time, consumption has risen, and income has risen, so the stimulus has worked.

Note that in this model, Professor Fama’s second proposition is true in equilibrium, and yet the stimulus still works in the sense of increasing income. In fact, even the tiniest of stimuli will be completely
effective in raising income to its maximum level. Any larger stimulus will still increase income, but it will also crowd out investment one for one.

One could certainly argue on empirical grounds that it is unrealistic to assume that savings do not respond to changes in income. Maybe “crazy” is a better word than “unrealistic.” If
anything, the Keynesian model probably assumes that savings respond less to income than they actually do. In which case you can do an even larger stimulus without crowding out investment.

“1. Bailouts and stimulus plans must be financed. 2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds. 3. Thus, stimulus plans only
enhance incomes when they move resources from less productive to more productive uses. Are any of these statements incorrect?”

Yes. Number 2 is incorrect because stimulus is monies in addition too normal spending and would not be injected under normal circumstances. They are not the same funds by any stretch of the imagination.

Number 3 is true, and seriously demented for the fact that it basically states, “Only supply money where the highest ROI rests.” If you are a Capitalist, this sounds great. If you are a humanist, it
is disastrous.